IOSR Journal of Business and Management (IOSR-JBM)

e-ISSN: 2278-487X, p-ISSN: 2319-7668. Volume 18, Issue 6 .Ver. I (Jun. 2016), PP 20-27

www.iosrjournals.org

DOI: 10.9790/487X-1806012027 www.iosrjournals.org 20 | Page

Are Macroeconomic Factors Substantially Influential For Islamic

Bank Financing? Cross-Country Evidence

Shamsun Nahar1, Niluthpaul Sarker

2

1(Ph.D Fellow, School of Accounting, Zhongnan University of Economics and Law, P.R. China)

2(Ph.D Fellow, School of Management, Huazhong University of Science and Technology, P.R. China)

Abstract: The advent of Islamic finance has created a significant change in global financial setup and with the introduction of Islamic banking system. The objective of this study is to examine the influence of macroeconomic

factors on the financing of Islamic banks. The study used FGLS regression method to analyze the unbalanced

panel data of 172 Islamic banks from 48 Muslim and Non-Muslim countries that met the selection criteria and

had at least three years financial data obtainable for the period spanning from 2004 to 2013. The results found

that GDP growth rate and inflation rate have significant positive relationship with Islamic bank financing. The

effect of exchange rate on Islamic bank financing was found negative, and as expected the Islamic bank

financing was found to be positively significant for countries with Muslim population in majority. However,

surprisingly and inconsistent with the general reports on remarkable growth of Islamic banks after global

financial crises, the study found insignificant results for financing volume of Islamic banks during the post

global financial crises period.

Keywords: Islamic Banking, Macroeconomic Factors, Islamic bank financing, Bank Credits, Panel data.

I. Introduction In the past decade increasing attention has been given to Islamic banking system, one major reason of

this growing popularity of Islamic banking system was the resilience of Islamic banking as witnessed during

global financial crises (GFC). Despite the financial turmoil in 2008, that crippled most of the Western

institutions, Islamic banks continued to grow in size and distinction. Asian Banker Research states that the

worlds 100 largest wholly Islamic banks, ranked by assets, held more than $580 billion in assets in 2008, a 66%

increase from the $350 billion they held in the previous year, which clearly depicts that Islamic banks came out

of this crises quite unscathed as opposed to its conventional counterparts.

The Global Islamic Finance Report (2014) [1] estimated the size of the global Islamic financial services

industry at $1.813 trillion at the end of 2013 with an estimated annual growth of more than 15% per annum.

Presently, Islamic banking growth rate is 50% faster than overall banking sector in several core markets and

Islamic banks are now operating in more than 83 countries around the world which includes Muslim countries

i.e Bahrain, UAE, Saudi Arabia, Malaysia, Brunei and Pakistan etc. and non-Muslim countries like USA, UK,

Canada, Switzerland, Australia, South Africa and others.

Existing literature lacks the comprehensive research on examining the financing portfolio of whole

Islamic banking industry. This study will bridge this gap by discussing different macro-level factors that

influence the lending decisions of Islamic Banks, so that it contributes to the researchers and policy makers

notion.

There is a general agreement in literature that Islamic banks are superior to conventional or mainstream

banks in terms of their performance (Safiullah, 2010 [2]; Samad, 2004[

3]; Awan, 2009[

4]; Rosly and Abu Bakar,

2003) [5]. Different studies related to Islamic banking have been conducted in different areas while considering

the importance of Islamic banking.

It is evident from the literature that numerous studies have focused on determinants of conventional

bank lending while neglecting determinants of Islamic banks financing. There are macroeconomic factors that

influence the Islamic bank credits. Thus, in this study we include macroeconomic factors- conventional banks

interest rate, GDP growth rate, inflation and exchange rate, in order to study the impact of these variables on

Islamic bank lending in 48 countries having established Islamic banking setup for the period from 2004 to 2013.

II. Literature Review In the literature, there are many empirical studies that disclose the relationship between macroeconomic

variables such as interest rate, inflation, exchange rates, money supply, etc., and conventional and/ or Islamic

bank financing. The literature divided the determinants (factors) of banks financing in two types: the first is the

micro-economic factors such as bank size, bank capitalization, liquidity and asset quality, capital ratios and

collateral security and the later one refers to the macroeconomic factors such as money supply, interest rates,

economic growth, inflation rate, exchange rate, and stock market index etc.

Are Macroeconomic Factors Substantially Influential For Islamic Bank Financing? Cross-Country..

DOI: 10.9790/487X-1806012027 www.iosrjournals.org 21 | Page

In our studies, we, therefore, include macroeconomic factors i.e. conventional banks interest rate,

economic output (GDP),inflation rate and exchange rate as explanatory variables in the study to examine the

impact of these variables on Islamic bank financing in 48 countries, that have established Islamic banking setup,

for the period from 2004 to 2013.

A review of literature on the effects of macroeconomic factors on financing portfolio of Islamic banks

has led to the decision of including the four variables. Thus four explanatory variables and two dummy variables

are selected according to the literature review and their relevance to the subject matter.

Macroeconomic factors: Interest rate, GDP growth rate, inflation and exchange rate.

Interest Rate: The amount/ rate charged by lenders as compensation for the loss of their asset/ capitals use, it

is the most important factor affecting the demand and supply of bank credit. In a study to investigate the impact

of interest rates on Islamic Banks financing in a dual banking system, Kader & Leong (2009) [6] consider the

effect of interest rate fluctuations on the demand for Islamic banks financing in Malaysia, collecting monthly

data for the period from 1999 to 2007. The findings suggest that interest rate is positively associated with

Islamic bank credits but negatively related to the conventional bank financing.

Rosly (1999) [7] describes the theoretical explanation of the effect of interest rate fluctuations on

performance of Islamic banks in a dual banking system. He found that Islamic banks are susceptible to interest

rate risks more than the conventional banks because of the over dependence of Islamic banks on BBA financing

in which the profit rates (financing rate) are fixed. Unlike Kadir and Leong (2009) [6] and Rosly (1999) [

7],

Adebola et al. (2011) [8] found that interest rate has significant negative effect on Islamic Banks financing in

Malaysia, which is taken to mean that Islamic banks financing is complementary rather than substitute to

conventional banks financing.

The current study also investigates the relationship between interest rate and financing of the Islamic

banks. Conventional banks lending interest rate is selected to measure the interest rate and the following

hypothesis analyzes the relationship between interest rate and loan portfolio of the Islamic banks and to examine

if the relationship is positive or negative:

Hypothesis 1: There is significant negative relationship between interest rate and financing of the Islamic

banks.

GDP Growth Rate: Economic output is one of the most important macroeconomic factors. The causal nexus

between economic growth and bank lending is bidirectional, and many studies have been conducted to analyze

the effect of one over the other. Tajgardoon et al. (2012) [9] explains that increase in GDP growth rate will

influence bank financing by creating more investment opportunities and better financing prospects, rendering

the banks and investors with ample opportunities to grow and henceforth increasing the demand and supply for

bank (Islamic) financing.

Mansur and Elyasiani (1995) [10

] found that bank loans have a positive relationship with stock prices

and real output. Karim et al. (2011) [11

] used inflation and GDP growth as control variables while analyzing the

effect of interest rate on Malaysian bank financing; he found negative results between interest rate and bank

financing.

Demetriades and Hussein (1996) [12

] find that there is a bi-directional causality between bank financing

and economic growth. Likewise, when we looked at the contemporary theoretical and empirical studies the

relationship between economic growth and financing nexus, (Greenwood and Jovonavic (1990) [13

]; Bencivenga

and Smith (1991) [14

]; Roubini and Sala-i-Martin (1992) [15

]; King and Levine (1993a) [16

]; Greenwood and

Smith 1997) [17

] indicated that growth and financial structur